Free Trade and Protectionism
Overview and definition of Free Trade Types of Protectionism • Definition of Free Trade Free trade is a system that allows countries to trade and transact without the governtment interfering those use of tariffs, quotas, subsides, etc. An ideal trading situation is one of free trade, because each country has comparative advantages in producing certain things. : • Tariffs Tariffs are taxes that are placed on imported goods. They raise revenue for the government, but also raise the price for the citizens because the domestic equilibrium price is higher than the interntaional price. Foreign suppliers find that they cannot sell as many goods as they previously could, thus cutting their overall revenue. : • Quotas A quota is a limit that a country places on goods from another country. Limiting the supply of this good then raises the price of the imported good compared to which the price would be under free trade. Quotas make it easier for domestic producers to compete with foreign producers. : • Subsidies A subsidy is definied as a grant paid by the government to an enterprise that benefits the but. Subsidies are a form of financial assistance that are generally given by the government of a country to a producer in a given industry, usually to keep the industry afloat and help keep production steady. Common subsidies include money to expand a company or to hire more workers. Subsidies are also a trade barrier, as subsidizing companies within the country makes it harder for foreign companies to compete. : • Voluntary Export Restraints (VERs) VERs are limits imposed by the government of a given country, which set a number of goods that can be exported during a given period of time. However, since VERs are imposed by the government, they are not really 'voluntary'. : • Administrative obstacles : • Health and safety standards: Basically, we are not accepting goods because of possible health risks. If something was to go wrong, then many lives would be at stake both in the United States and outside counrties. Any industry crucial to national security, such as producers of military hardware, should be protected. That way the nation will not have to depend on outside suppliers during political or military crises. National security'' is at stake'' with regard to some industries. Defense is the best example of an industry that requires protection on the basis of national security. Steel may be another, but the steel industry has been only partly successful with this argument. Oil is another industry on which national security can depend, although U.S. consumption of and dependence on foreign oil has been virtually encouraged by the phase out of fuel efficiency standards for passenger vehicles and low gasoline taxes (relative to those in Europe). Although economists disagree about various ways to protect industries on which national security depends, most agree that some industries warrant such protection. They also agree that some industries that have claimed this status probably do not warrant it. It all depends on how much we are willing to sacrifice our health and safety standards in the free trade and protectionism. If we value our safety more, it will be harder to accept free trade. It is the WTO's job to determine the what is considered "healthy" and "safe, and also to ensure that health and safety regulations are not being used as excuses from protecting domestic producers. Governments agree on how to apply food safety and animals and plant health measures. : • Environmental standards: From an environmental viewpoint, free trade is not necessarily a good thing. It is a generally accepted concept that the environment will suffer if trade is liberalized. One reason that the standards are bound to worsen is that the international trade law under WTO regulations gives countries and incentive to decrease environmental regulation of domestic production, so that the domestic producers will be on the same level as the foreign competition. Another concern had is that the ideals behind the General Agreement on Tariffs and Trade (GATT) support the policy of “product, not process”. This prohibits the discrimination of trade based on how it is produced, which causes producers to use the cheapest methods available to make their good, which are often the most damaging methods for the environment. Businesses want to produce as cheaply as possible, and not reducing pollution saves them a lot of money. Domestic producers can claim that foreign producers have an unfair advantage because of their country’s lower environmental standards, so the domestic producers lobby for lower standards at home, so they can still compete. An example of this is the tuna-dolphin scandal between the U.S. and Mexico, which began in about 1960, but continued far beyond. The U.S. imposed trade restrictions on Mexico because of the large number of dolphins killed by their tuna fishermen. Mexico appealed to GATT and won, with GATT deciding that the U.S. was imposing unfair trade practices, and that they had overlooked several less extreme options when they used an embargo. As a result, U.S. canneries started to print “dolphin-friendly” on their labels, because people don’t like things that hurt dolphins, and would much rather buy dead tuna that doesn’t do so. There is some argument that the predicted environmental consequences of free trade are exaggerated, but in general, the theory is accepted. Now it’s just a race to see which will win, trade or the environment. Arguments for Protectionism : • Infant industry argument - If an industry is newly developing in a country, it will not be able to be competitive with international prices from companies that have been producing the particular good for a long time. The government sets up trade barriers in order to protect this industry until it is developed enough to keep up in the world market. However, if the industry continues to be protected, it may never become ready for the world market because it has not had an incentive to be more efficient and therefore cheaper. : • Efforts of a developing country to diversify '- A country should diversify because if it only produces goods in a few industries, if something bad happens to those industries they could be in a lot of trouble financially. With small countries, this is very common, so we encourage them to diversify so this doesn't happen. : '• Protection of employment -'T'his argument stems, usually from misguided patriotism. The claim is that buying goods from other countries as opposed to domestic producers will destroy jobs at home. The counter argument is that buying at the lowest price allows for higher levels of production and other lost jobs will be made up in other sectors and by lowered input prices. : • Source of government revenue- tariff equals bringing in government revenue : • Strategic arguments- 'A country should avoid importing weapons and other materials for national security from other countries. For example, if country A is receiving national security technology from country B, and they end up in conflict with each other, country A is at risk. : '• Means to overcome a balance of payments disequilibrium- putting a tariff on imports so our consumers want to buy domestic products rather than foreign products : • Anti-dumping- selling something in a foreign market much cheaper than you sell it for domestically Arguments against Protectionism : •''' Inefficiency of resource allocation '- When a country produces a good that it does not have a comparative advantage in producing, the country pays a higher opportunity cost and there is net welfare loss because of the increased opportunity cost. When a country does have comparative advantage, it is much less of an opportunity cost to obtain it from them. : '• Costs of long-run reliance on protectionist methods-Countries who place''' trade barriers in place for the infant industry argument assume that eventually the domestic industry will be able to compete internationally. However, the industry may use the barrier as a crutch and never properly develop its product. : • Increased prices of goods and services to consumers : • The cost effect of protected imports on export competitiveness